Friday, February 15, 2013

LNG - Some Inconvenient Truths

I do not doubt that there need to be some LNG terminals on the west coast of North America, but how many and where? Even more importantly, who will pay for them?

If private industry foots the bill for LNG plants in BC without any government subsidy, they let them build, but if they seek some form of government support of subsidy to build them, then I can not support the idea. As I said, there is a need for LNG terminals on the west coast of North America, but let the Americans build them if government needs to subsidize them.

What I am skeptical about are the potential revenues and jobs this industry would bring to BC. LNG is currently wildly popular because there is a big premium between the price of natural gas in BC and the price in Japan. The Australians were lucky to have the LNG infrastructure in place when Japan overnight increased their demand for natural gas. In 2011 the Japanese shut down their nuclear power plants after the Sendai earthquake and needed a sudden infusion of natural gas to create electrical power. This boosted the spot price dramatically but this high price is projected to be gone by 2014 or 2015, some three to five years before there may be any large scale LNG plants in BC.

In the last decade there has been a major change in technology for natural gas extraction making shale gas and coal bed methane economic. Suddenly the US, one of the biggest importers of natural gas in the past, will be a natural gas exporter. This has meant the collapse of price for natural gas in North America. These low prices, coupled with the royalty regime in BC, means that government revenues from natural gas here have been low, a lot lower than anyone would have thought possible.

Unconventional gas has expanded to other parts of the world and means that the spot price for natural gas is no longer closely linked to the price of crude oil. Many long term LNG contracts for natural gas have been designed to mirror crude oil prices and now customers want out of those. Recent long term contracts for LNG have been structured to be 30% lower than in the past. I suspect that within a couple of years the long term price for LNG will be within $4-$5 of the spot price of natural gas in North America, just enough to cover the added expense of making and transporting LNG.

One reason long term LNG prices will be lower is because there are plans all over the globe to build new LNG facilities and for new natural gas pipelines. There are close to 35 proposed LNG plants under consideration globally at this time, five of them in BC. There are 28 LNG plants currently in operation so if all the proposals were to go forward the globally LNG supply will more than double. LNG is always a less preferable option than a pipeline because piped gas is much cheaper.

As more natural gas pipelines are constructed the ability to move natural gas around becomes easier and the options for customers goes up. There are many pipelines proposed or under construction in Russia and Europe and now there are plans for more in Asia as well. Russia has just opened the Sakhalin–Khabarovsk–Vladivostok pipeline which is planned to be expanded to South Korea and Japan. Japan and South Korea are the number 1 and number 2 LNG importers in the world accounting for almost half the LNG imports in the world, taking them off of the market will mean we already have more LNG capacity that the world needs. Russia is also likely to build the Altai gas pipeline to china within the next few years, that pipeline coupled with increased internal supply in China means it is unlikely to be a new source for LNG imports.

With more connectivity in the market the large price differentials around the global will disappear. Overall the global price is not likely to rise much because the potential for supply is so much larger now than it was a decade ago.

LNG makes sense if you can get an increase of $4 or more per mmBTU of natural gas. If the global price differentials disappear the economics of LNG plants do not make sense. All you are left is selling LNG to countries not connected a pipeline system and that market is not huge and getting smaller.

Being closer to the market than your competitors helps with LNG. BC may be closer than the US Gulf Coast but is no closer to Japan than the Australian LNG terminal. The Mayalsian and Indonesian LNG terminals are about 2000 km closer. BC has no serious competitive advantage over most competitors, even the proposed LNG terminals in Oregon are only 800 to 900 km further from Japan than the proposed BC ones.

The higher cost to produce LNG means that extra royalties on it can only occur when there is a price for LNG that is high enough above the local natural gas prices to sustain profits and the government royalty. If LNG prices drop to anywhere close to $7 or $8 per mmBTU there is simply not enough meat on the bone for there to be a decent royalty and profits. BC could be competitive if it offered electrical power to the LNG plants at well below market rates, but do we really want to spend $7 billion or more to build site C so that we can sell cheap power to LNG plants?

The companies behind the proposed LNG plants for BC have not yet committed to building. None of them are going to build the LNG plants unless it is clear to them that they will be profitable. Sinking $10,000,000,000 into a plant will only happen if the economics work. For a government to assume that it will happen is bad public policy. All government should be doing is setting up the regulatory and taxation regime for the industry. If it happens, great, if not, such is life.